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Ben Bernanke a Gold Bug’s Best Friend?

Serious signs of inflation in the economy would give gold fanatics a long-awaited I-told-you-so moment, having inaccurately predicted for years now that government spending and market interference would cause prices to rise quickly. Such a scenario is supposed to drive up the price of gold as the value of a dollar crumbles. The fanatics may yet be right about inflation, and some very important people are worrying about it too. But there’s a catch: gold investors have gotten poorer, not richer, because of that worrying.

Gold prices have dropped this year mainly because Federal Reserve officials have grown more concerned about inflation. At recent meetings of the Federal Open Market Committee, some of them worried that continuing the Fed’s bond-buying policy – that market interference gold bugs so disdain – is too risky because it could be inflationary. The possibility that the Fed might discontinue the buying sparked a massive outflow from gold in January when the minutes of that meeting were released. When the FOMC’s February minutes (released Feb. 20) showed Fed Chairman Ben Bernanke and his let’s-buy-aggressively cohorts were still in charge of policy, gold prices stabilized somewhat. Here’s a stock chart for the exchange-traded fund that tracks gold prices, SPDR Gold Shares (GLD):

GLD Chart

Bernanke as savior of gold prices is pretty ironic, considering his policies are the epitome of wrongheadedness in gold-bug-think. But the whole event raises a more fundamental question for any gold investor: what, really, can make the price of gold rise again?

The go-to answer to that question has always been inflation. Big government spending, particularly via bailout plans and direct buying in the bond markets, was expected to spark serious, even runaway, inflation, among gold devotees. Inflation, arguably, makes gold more valuable because it becomes a safe haven when currency values decline. This expectation was a critical factor in the doubling of gold prices between 2007 and 2011.

At the moment, though, any sign of inflation in the economy backfires on gold investors because it makes the Fed more likely to end its bond buying program. Bernanke’s plan calls for intervention until the job market improves, but even he would likely cut it short if the price of goods started rising quickly. And that program, it turns out, is critical for maintaining market expectations for inflation; perhaps more critical than investors realized.

The problem is that the evidence of worrisome inflation in the economy is slim even as the Fed continues to play along. January data shows both consumer and producer core prices up less than 2% in the previous 12 months.

US Core Consumer Price Index Chart

Anything that spooks the Fed out of the market now would lower the likelihood of problematic inflation in the future, and most forecasters already put that likelihood at pretty low. The Fed’s inflation forecasts remains at or below 2% through at least 2015. While there’s sure to be skepticism from certain camps about government inflation forecasts, it looks like many investors believe in this one. For example, the ProShares 30 Year TIPS/Treasury spread chart (RINF) rises with inflation expectations. (It measures the difference between inflation-protected securities and plain Treasury bonds). It’s not exactly going vertical now.

Really, the best thing for gold bug fortunes now would be for the Fed to keep doing the thing they find most distasteful; steadily plying billions of dollars into the markets, feeding fears of inflation. Right now, Ben Bernanke is about the best friend a gold investor could want.

Dee Gill, a senior contributing editor at YCharts, is a former foreign correspondent for AP-Dow Jones News in London, where she covered the U.K. equities market and economic indicators. She has written for The New York Times, The Wall Street Journal, The Economist and Time magazine. She can be reached at editor@ycharts.com.